Special Allocations and Preferential Distributions in Joint Ventures Involving Taxable and Tax Exempt Entities

Joint ventures involving taxable and tax-exempt organizations, referred to in this article as taxable-tax exempt joint ventures, engender conflict between the doctrinal requirements pertaining to tax exemption and the flexibility afforded joint ventures in Subchapter K.\u27 The nonprofit partner must exercise ultimate governing control over the joint venture so that charitable goals take precedence over profit-seeking goals if the nonprofit\u27s share of income is to remain tax exempt. On the other hand, a for-profit partner is entitled and indeed expected to pursue profit but its lack of control over the joint venture exposes the for-profit partner to greater risk of loss than it would confront in other investments. In essence, a for-profit partner in a taxable-tax exempt partnership must assume the role of a limited partner. The nonprofit partner must act as exclusive general partner. In normal partnerships, a limited partner would demand certain risk avoidance or compensation concessions-special allocations, guaranteed payments, and preferred returns -in recognition of the higher risk arising from its lack of control. Those risk avoidance and compensation methods usually have two primary effects. First, they elevate one partner\u27s return potential over those of another. Second, they indemnify one partner, to a certain extent, at the expense of another. These effects seem inherently inconsistent with the control mandate, and yet it is unreasonable to think that for-profit partners will participate in taxable-tax exempt joint ventures without insisting on risk avoidance and compensation. This article analyzes the degree to which a taxable-tax exempt partnership or limited liability company can make use of risk avoidance and compensation methods available in Subchapter K without running afoul of doctrinal requirements for tax exemption. The article concludes that the policies underlying tax exemption should prevail over the policies embodied in Subchapter K, but that the Subchapter K policies should nevertheless apply to the extent they are not inconsistent with tax exemption